Fitch Ratings dropped Milwaukee’s general obligation rating by two notches and S&P Global Ratings cut it by one over rising budget strains amid limited revenue-raising prospects and both warned of further negative action that’s dependent on how the city tackles a looming pension funding spike.
The rating actions over the last week come ahead of the city’s competitive sale of $23.8 million of GO promissory notes and $9 million of GO bonds Nov. 30, according to Joshua Benson, capital finance manager in city Comptroller Aycha Sawa’s office, which manages city borrowing.
Fitch cut the rating two notches to A from AA-minus and retained a negative outlook. It affirmed the city’s water bonds at AA but revised the outlook to negative from stable.
The downgrade “reflects significant operating pressure temporarily mitigated by the infusion of substantial federal stimulus,” Fitch said. “Growing expenditures well above the rate of revenue growth and the inability to independently increase revenue may lead to significant declines in financial resilience if the city does not receive an infusion of revenue or implement large cuts to core services.”
“The negative outlook partially reflects Fitch’s concern that the city has not yet presented a plan to fund the higher pension contribution costs in the long run, although the increase in the pension reserve fund provides temporary breathing room,” Fitch said.
S&P lowered the rating to A from A-minus and assigned a negative outlook. It also lowered the rating on sewage revenue bonds backed by a city appropriation pledge to BBB-plus from A-minus, but the outlook is stable.
“The lowered rating reflects our view of the city’s budgetary flexibility profile, which is trending towards very weak levels, with severely limited revenue-raising flexibility options,” said S&P analyst Andrew Truckenmiller.
“The negative outlook reflects our view of the city’s substantial anticipated increase in annual pension costs beginning in 2023 and the potential adverse effects of this increase on the city’s budget without a long-term readjustment of revenues and expenditures to accommodate these higher pension costs,” Truckenmiller said.
The actions mark the latest bout of rating troubles. Moody’s Investors Service in September downgraded the city to A3 from A2 and left a negative outlook attached to the rating.
The city’s reserves fell to $30.6 million, or 4.2% of expenses, in 2021 from $108 million, or 16%, in 2015. The city’s revenue-raising prospects have long been limited by state tax caps and stagnant state aid levels. The pension burden poses a further drag on future budgets.
The city and other local governments in the state continue to lobby for the ability to enact a local option sales tax that could raise between $55 million and $60 million for the city, but its fate is uncertain.
“We are disappointed with the recent rating actions on the city. While we acknowledge the challenges the city is facing we believe that downgrade does not accurately portray the city’s ability and willingness to repay its existing and future debt obligations,” the comptroller’s office said.
“If the city is unable to establish a credible plan to fund its upcoming annual increases to pension costs that would enable it to maintain balanced operations as these costs accelerate, we could lower the rating,” S&P said. “Additionally, if its reserve position were to go negative for any reason, a lower rating is possible.”
The city’s contribution to the Employee Retirement System is estimated to rise by at least $50 million —from the current $77 million — when a new actuarially based contribution is set for the next five-year cycle. The system has a net liability of $382 million. Milwaukee’s net pension liability for its ERS plan fell sharply from $851 million in 2020 because of strong investment returns but it is at risk of rising in the face of weak returns this year.
The city has set aside $42 million in a special reserve and budgeted another $40 million in 2022 to help manage the spike.
City officials say a plan is in the works, with the reserves providing a cushion to get there.
“The city of Milwaukee is developing a multi-year plan to use the segregated reserve fund as well as the 2023 pre-payment to bridge the transition into a new five-year stable funding window,” Budget and Management Director Nik Kovac said in an email. “This plan will be formalized and announced during 2023 once the ERS Board has completed its due diligence.”
The newly passed 2023 budget includes a $100 million pre-payment toward those likely future increased obligations. The revised payment will be due in January 2024 with the final amount not determined until early next year.
“The timing of this decision is based on unusual volatility in capital market assumptions and the market value of assets during 2022 YTD,” Kovac said. “This timing will allow the board to ensure that discount rate and other actuarial assumptions are as accurate as possible for the coming five-year window.”
The city has some one-time tools to deal with structural gaps in the short run including the pension reserves as well as available general fund reserves. The city can also tap up to $41 million in its public debt amortization fund for general purposes through issuance of short-term notes, Fitch noted.
Balanced operations that improve reserve levels while also meeting the pension costs would restore a stable outlook, S&P said. The city’s 2022 budget anticipates using $4 million in reserves and management reports the year-end result could be anywhere between balanced to a $5 million operating gap.
The city received $394 million of federal COVID-19 American Rescue Plan Act relief and will apply $160 million toward the 2023 and 2024 budgets under the revenue loss category of permitted uses.
“The significant use of ARPA funds for recurring costs exposes the city to a structural deficit once the funds are exhausted, while the potential under-budgeting of pension increases may leave the city with lower reserve levels to address the looming gap,” Fitch warns.
A mayoral task force on pensions last year warned a 24% cut in the workforce could be needed to manage the payments in the absence of new revenue. City property taxes fall under state caps, the state’s sales and income tax revenue sharing program has been stagnant for years, and other revenue-raising options are limited.
One proposal would direct some collections to property tax relief while police and fire unions are pushing to include language barring personnel cuts. Some are advocating for folding new employees into the state’s fully funded retirement system. Pension obligation bonds could be on the table in a legislative package.